Commodities of all stripes are in freefall in synch with crude oil, with the DB Commodities Tracking Index Fund (NYSEARCA:DBC) at levels that haven’t been seen since 2009. And while consumer-oriented and transportation stocks led the way higher on Friday — on enthusiasm over lower energy prices — the S&P 500 sank Monday as investors realized it is highly exposed to companies that will suffer from cheaper oil and commodity prices. That’s not just energy and materials producers, but also banks that lend to them and technology companies that sell to them. Moreover, a crash in commodity prices rarely happens outside of a broader slowdown in the economy and corporate profits.
Deflation can help support a boom if it is orderly, as lower inflation helps support higher price/earnings multiples.
When it is rapid and chaotic, deflation causes problems because the foundation of a bull market is rising asset prices. When prices for things drop, profit margins are squeezed, collateral becomes less valuable, margin calls increase, and capital expenditures are pulled.
It’s notable that the NYSE Composite, one of the broadest measures of the market, is hitting resistance from a possible triple-top pattern as the ratio of stocks to bonds is rolling over in a way that hasn’t been seen since late September.
Given all this — and the likely return of political rancor in Washington as the White House and Congress clash over the mid-December budget deadline, immigration, and the March debt ceiling deadline — the persistent rise in stocks since mid-October could hit a wall.
Still, don’t count the bulls out. They have been waiting for a pullback from the torrid advance since mid-October, and my expectation is that despite all the trouble with the energy complex and underwhelming early reports from malls on holiday shopping, they will find a good excuse to resume buying. Never forget that the central banks are on the bulls’ side, and their ardor and dedication to keep asset prices moving higher has been the main motivating force for five years — and that is unlikely to change now.
This article is brought to you courtesy of Jon Markman.